Extraterritorial Application of Federal Securities Law After Morrison
May 15, 2023
In Morrison v. National Australia Bank (2010), the U.S. Supreme Court applied the presumption against extraterritoriality to the principal antifraud provision of the Securities Exchange Act, section 10(b). It held that section 10(b) applies “only [to] transactions in securities listed on domestic exchanges, and domestic transactions in other securities.” As I have explained elsewhere, Morrison fundamentally changed the presumption against extraterritoriality, adopting the more flexible, two-step approach that the Supreme Court uses today.
Of course, Morrison also changed the test for applying section 10(b) in transnational litigation. Morrison’s “transactional test” was meant to establish a clear, bright-line rule. For listed securities, it works well: a transaction on the New York Stock Exchange occurs in the United States and is subject to section 10(b). But Morrison’s test becomes blurry when applied to unlisted securities that do not trade on an exchange. In this post, based on an essay in honor of Professor Linda Silberman, I look at the post-Morrison decisions applying section 10(b) to unlisted securities and suggest that the problem requires a legislative or regulatory solution.
When Is a Transaction in Unlisted Securities “Domestic”?
Morrison’s “transactional test” applies to both listed and unlisted securities. Transactions in listed securities occur wherever the exchange on which they are executed is located. But how should a court determine the location of unlisted securities?
The Second Circuit first addressed this question in Absolute Activist Value Master Fund Ltd. v. Ficeto (2012), which remains the leading case. Absolute Activist held “that transactions involving securities that are not traded on a domestic exchange are domestic if irrevocable liability is incurred or title passes within the United States.” The First, Third, and Ninth Circuits have each adopted the “irrevocable liability” part of the Second Circuit’s test.
The irrevocable liability test has in turn raised further questions about how to tell where the parties become bound. This is a question of contract law, and the answer may depend on what law governs the contract. Even when the governing law is clear, however, the answer may not be. In Cavello Bay Reinsurance Ltd. v. Shubin Stein (2021), a Bermudan corporation bought shares in a Bermudan holding company headquartered in New York. The seller sent a subscription agreement from New York to Bermuda where the buyer signed and returned it. The seller then signed the agreement in New York and mailed an executed copy to Bermuda. Title to the shares passed at the closing in Bermuda. The subscription agreement was governed by New York law. But the parties disagreed about whether, under New York law, the agreement became binding when it was signed by the seller or only when it was received in Bermuda. “Here, the place of transaction is difficult to locate,” the Second Circuit noted, “and impossible to do without making state law.” Ultimately, the court resolved the case on the alternative ground, discussed below, that section 10(b) did not apply because the transaction was “predominantly foreign.”
Further complications arise when a transaction may be cancelled or is subject to approval. In Choi v. Tower Research Capital LLC (2018), plaintiffs bought futures on the “night market” of a Korean exchange. Orders placed in Korea when the exchange was closed were matched with counterparties on a trading platform in Illinois and then settled in Korea the next day. The defendant argued that irrevocable liability was not incurred when trades were matched in the United States because the exchange could cancel transactions in case of errors. But the Second Circuit held that the parties incurred irrevocable liability in the United States because, absent error, the parties were bound when the trades were matched.
In Giunta v. Dingman (2018), plaintiff invested in defendant’s business in the Bahamas after a series of meetings in New York. The district court agreed with the defendant that irrevocable liability was not incurred in New York because Bahamian authorities still had to approve the issuance of shares. But the Second Circuit reversed, holding that the existence of “a condition subsequent does not mean that either party was effectively free to revoke its acceptance, or change its mind until the approval of the shares abroad.” These two cases do not exhaust the factual situations in which transactions are subject to cancelation or approval. If the investors had reserved the right to cancel in Choi, or if regulatory approval had been a condition precedent rather than a condition subsequent in Giunta, those cases might have turned out differently.
These cases show that Morrison’s “transactional test,” and Absolute Activist’s “irrevocable liability” gloss, have not produced a clear, bright-line rule for unlisted securities. The problem with the rule is not just its fuzziness but also its randomness. For listed securities, tying section 10(b) to the location of the exchange makes sense because it coincides with the expectations of the parties and allows them to choose a level of antifraud protection they desire. For unlisted securities, by contrast, there seems to be no good reason why the applicability of section 10(b) should turn on where the buyer signs the subscription agreement or where orders for futures on a foreign stock exchange are matched.
As Hannah Buxbaum has noted, sellers of securities can manipulate the place of acceptance in ways that are not transparent to buyers, depriving them of the protection of U.S. law without their knowledge or consent. Indeed, I am told by a friend who practices in the area that lawyers regularly advise clients to sign agreements outside the United States to avoid the application of U.S. securities law.
A more extreme example of randomness is presented by the Parkcentral case, discussed below. There, investors bought securities-based swaps in the United States to bet on the price of foreign securities on foreign exchanges and suffered losses because of false statements by foreign persons abroad. Should the investors be able to sue the foreign persons who made the statements—persons not parties to the swap agreements—in U.S. court under section 10(b) simply because the transactions occurred in the United States? The Second Circuit answered no, but only by blurring Morrison’s bright-line test even further.
Predominantly Foreign Claims
Lower courts have also struggled with whether Morrison’s transactional test is exclusive. The Second Circuit held in Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE (2014), that a domestic transaction is a necessary but not a sufficient condition for applying section 10(b). Even when securities are purchased in a domestic transaction, the court held, section 10(b) does not apply if the plaintiffs’ claims “are so predominantly foreign as to be impermissibly extraterritorial.”
In Parkcentral, plaintiffs bought securities-based swaps referencing Volkswagen stock. Plaintiffs alleged that Porsche and its executives made false statements in Germany, some of which were repeated in the United States, denying Porsche’s plans to acquire Volkswagen. Although plaintiffs alleged that the swap agreements were concluded in the United States, the Volkswagen stock referenced by the swaps traded only on European exchanges. In other words, the question facing Second Circuit was whether section 10(b) should apply to statements made in a foreign country, concerning securities of a foreign company, traded exclusively on foreign exchanges, just because the swap agreements were concluded in the United States.
The Second Circuit said no. First, the court reasoned that, although Morrison held that a domestic transaction is necessary for section 10(b) to apply, it did not say that a domestic transaction is sufficient. The court went on to hold that section 10(b) does not apply to domestic transactions when the plaintiffs’ claims are “predominantly foreign.” That was true in Parkcentral “because of the dominance of … foreign elements,” including the place of the false statements, the nationality of the company, and the location of the exchanges where its stock trades. Rather than attempting to articulate a test for when claims are predominantly foreign, the panel cautioned that “courts must carefully make their way with careful attention to the facts of each case and to combinations of facts that have proved determinative in prior cases, so as eventually to develop a reasonable and consistent governing body of law on this elusive question.” The Second Circuit subsequently extended Parkcentral’s “predominantly foreign” test to the Commodity Exchange Act.
Other circuits have found Parkcentral’s approach to be contrary to Morrison. In Stoyas v. Toshiba Corp. (2018), the Ninth Circuit adopted the Second Circuit’s “irrevocable liability” test for unlisted securities but rejected its additional “predominantly foreign” test. Among other things, the court noted that “Parkcentral’s test for whether a claim is foreign is an open-ended, under-defined multi-factor test, akin to the vague and unpredictable tests that Morrison criticized and endeavored to replace with a ‘clear,’ administrable rule” and that the test “relies heavily on the foreign location of the allegedly deceptive conduct, which Morrison held to be irrelevant to the Exchange Act’s applicability.”
In SEC v. Morrone (2021), the First Circuit similarly adopted the “irrevocability test,” rejecting Parkcentral as “inconsistent with Morrison.” “Morrison says that § 10(b)’s focus is on transactions,” the court noted. “The existence of a domestic transaction suffices to apply the federal securities laws under Morrison. No further inquiry is required.”
It is hard to fault either the Second Circuit or the First and the Ninth for the positions they have taken. The Second Circuit is likely correct that section 10(b) should not apply in cases like Parkcentral, whereas the First and Ninth Circuits are right that Parkcentral’s solution to the problem is inconsistent with Morrison. The problem, it would seem, is that Morrison failed to anticipate cases where the location of the transaction bears little relationship to substance of the claims.
The Way Forward
Morrison promised a clear test for when section 10(b)—and potentially other provisions of U.S. securities law—apply to securities transactions with foreign elements. For listed securities, it has largely delivered on that promise. But for unlisted securities, Morrison has created a mess.
Lower courts have tried to clean up the Supreme Court’s mess by adopting an “irrevocable liability” test to determine the place of the transaction. But this test depends on the law governing the transaction and may turn on facts (like the place where a subscription agreement is signed) that bear little relationship to whether section 10(b) should apply. Some lower courts have tried to reach more sensible results by supplementing the transactional test with a “predominantly foreign” test, while others have rejected this innovation as inconsistent with Morrison. The fundamental problem is that Morrison’s transactional test is not well adapted for securities that do not trade on an exchange.
Congress might fix the problem by passing legislation to specify the geographic scope of section 10(b) for unlisted securities. In the process, Congress might even review the geographic scope of other provisions of the Securities Exchange Act, the Securities Act, and the Commodity Exchange Act, tailoring each to address the most serious problems for U.S. investors and issuers, while seeking to avoid unnecessary conflict with the laws of other countries. Readers may be skeptical, however, that the current Congress is up to the task.
Alternatively, the Securities Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) could issue regulations addressing the geographic scope of section 10(b) and other provisions for various kinds of unlisted securities. Congress has delegated rulemaking authority to the SEC and CEA.
I have argued that agencies are better positioned than Congress—and certainly better positioned than federal courts—to decide when different aspects of securities regulations should apply to transactions that cross borders. Moreover, at least until the Supreme Court overrules Chevron, the SEC’s and the CEA’s reasonable interpretations of the statutes they administer are entitled to judicial deference. And even an overruling of Chevron may not reach express delegations of rulemaking authority.
Morrison may have created a mess when it comes to unlisted securities, but the SEC and CEA have it in their power to clean this up.